Selling options on gold to profit from a bad economy

In case you didn’t hear the good news, the recession is over. The official announcement came in mid-September. Yes, indeed, it ended last year. So we can all quit our belly aching and get back to what we were doing.

Regardless, many high net worth investors are not feeling the love. Bad enough are impending tax hikes and suffering practices and businesses, but throw in that most asset-based investments (other than gold) have been lackluster at best, and you have a class of investors that is probably not yet ready to rejoice in the "slow but steady" growth.

Many investors say that because their stocks, real estate and other assets are performing poorly, an option-writing portfolio would have to suffer the same fate. Those investors would be wrong.

As an option writer, you have the ability to adapt your portfolio to any market or economic condition — bullish or bearish. Do it right and you will not only beat your other investments with this strategy, but you can thrive in an otherwise unfriendly economic climate.

The economy, Fed & commodities

New commodity investors need to grasp the importance of knowing the fundamentals of each commodity they are trading. Supply and demand play a major role in dictating price direction of any commodity such as crude oil, corn or silver. There are far fewer factors to consider when analyzing a commodity than there are when analyzing a stock. That’s one reason you may chose to sell commodity options vs. individual equity or equity index options.

While fundamentals are unquestionably important in commodities, there are times when macroeconomic conditions take center stage and must be given their due weight. Late 2010 appears to be one of those times.

The economic "recovery" is not happening as quickly as many would like, and there is the real fear that a double dip recession could occur. Even optimistic forecasts have the U.S. economy growing at only 2.5% to 3.0% next year. This has the Fed leaving the window open for further quantitative easing, which is Fed lingo for "we’re going to expand the money supply." All this in an effort to further stimulate the economy (further lower mortgage rates) and at the same time stave off deflation.

The Fed has pretty much announced another round of quantitative easing, QE2 as it has come to be called. The only question is how much and how open they will leave the window for more intervention. It has torpedoed the dollar and further spurred gold prices to new record highs. There has been some "buy the rumor sell the fact" action in mid-October, though, when it became a certainty involving both the dollar and gold, which are normally negatively correlated.

Despite the October correction, as long as the specter of quantitative easing looms, upside action in the U.S. dollar will most likely remain limited. And a weaker dollar is often a supportive factor to commodities.

Traders must be careful, however, not to position a full option selling portfolio based on one factor. A weaker dollar does not always mean a bull market in all commodities. Individual fundamentals of a commodity can offset or even trump the value of a weaker dollar. Each must continue to be judged on its own merits. For instance, a weaker economy could mean less demand for certain products, pressuring prices to the downside.

About the Author

James Cordier is the founder and head portfolio manager of Liberty Trading Group/OptionSellers.com. Michael Gross is an analyst with Liberty Trading Group. Together they wrote "The Complete Guide to Options Selling" (McGraw-Hill 2009). They can be reached at www.OptionsSellers.com